Fiscal cliff deal means paychecks will be smaller

The key issue in the fiscal cliff debate in Washington was how much to raise taxes and on whom, with the deal ultimately sparing most Americans from an income tax increase.

But in a development that attracted less attention Congress allowed one type of tax to increase for most of us, the Social Security payroll tax, effectively cutting the take-home pay of three quarters of American workers.

While Bay Area tax experts say many good things are to be found in the deal, including for the unemployed, middle-class parents of college students and the wealthy, the American Taxpayer Relief Act that Congress approved late Tuesday raises billions from workers and even those who are self-employed by allowing the payroll tax rate to rise to 6.2 percent from 4.2 percent.

The tax money goes toward old-age, survivors and disability insurance, or what commonly shows up on people’s paychecks as Social Security Insurance, or SSI.

By some estimates, the payroll tax hike means that people who make $50,000 a year will pay $1,000 more in taxes this year.

The Tax Policy Center in Washington, D.C., estimates that the expiration of the payroll tax cut will affect 77.1 percent of U.S. households, who will see average increases of $1,635, according to Bloomberg News.

“For most middle-income taxpayers, that’s the big change,” said Robert M. Caplan, a Foster City certified public accountant who is also a member of the California Society of CPAs’ tax and estate planning committees. “With the exception of the payroll tax increase, for most people there was lots of good news.”

People who have been out of work more than six months will now get a one-year extension of their unemployment benefits. School teachers will still get to deduct up to $250 of their expenses for classroom supplies. And families received five-year extensions on a variety of credits, including the American Opportunity Tax Credit for sending their children to college.

And many others are breathing a sigh of relief, including middle-income and wealthy earners in the Bay Area, who were spared facing the Alternative Minimum Tax for their upcoming 2012 returns when Congress permanently indexed the AMT to inflation.

“That is a really big deal and a big win,” said Michael Gray, a San Jose CPA. “We were looking at having 30 million Americans thrown into the AMT that would have cost them thousands of dollars. Particularly for people in California, that’s a huge collective sigh of relief.”

The agreement in Washington also makes permanent a lifetime gift-tax exemption of $5 million, with a maximum estate and gift tax rate of 40 percent.

For married couples with adjusted gross incomes of $250,000 or more, a 3.8 percent Medicare tax on certain investment incomes remains in place.

Personal exemptions will be phased out for people making more than $250,000 and itemized deductions will be limited.

Of course, the biggest compromise in Washington made Bush-era tax cuts permanent for everyone but those making $400,000 or more — or $450,000 and up for couples filing jointly.

They’ll see a restoration of the 39.6 percent tax rate — up from 35 percent — and also will get increases in capital gains and dividends rates from 15 percent to 20 percent.

Chuck Putney of Walnut Creek’s Putney Klein Associates, spent Wednesday poring over the deal and expects to hear complaints about the tax implications from some of his high-earning clients.

But Putney is armed with an explanation.

He plans to tell his clients that the change to the payroll tax that affects so many taxpayers will help preserve Social Security.

“It’s analogous to saying that you’re putting money aside for your retirement,” Putney said.

If that fails, Putney has a fallback explanation to explain who will have to pay what this tax year.

“It’s all because of Congress,” he said. “It’s the result of a compromise between very conservative and very liberal elements.”

Contact Dan Nakaso at 408-271-3648. Follow him at Twitter.com/dannakaso.